Can we close the budget deficit by taxing the rich?

In my chat yesterday, someone asked if we could really eliminate the budget deficit by taxing the rich. The answer is no, but we could make it smaller by taxing the rich. The Wall Street Journal's David Wessel runs the numbers. Before we jump in, remember: The deficit over the next 10 years is projected to be $9 trillion.

Start with some rough arithmetic. The three million or so fortunate taxpayers whom Mr. Obama counts as rich are projected to earn about $27.5 trillion from 2010 through 2019, according to the Tax Policy Center, a Washington think tank, and about $23.9 trillion after deductions. They are projected to pay $7.4 trillion in taxes. That's 31.1% of every dollar of taxable income, on average.

To squeeze an additional $9 trillion out of these taxpayers would require boosting that to 68.9%. And that assumes these taxpayers wouldn't find tax shelters to hide their income or work less. There isn't enough money in the over-$250,000 crowd to stick them with the $9 trillion tab.

And this actually makes taxing the rich look better than it is. The deficit that people worry about isn't the $9 trillion short-term budget deficit. It's the mega-trillion long-term deficit. To put this in context, the 2009 deficit was 53 percent of GDP. The 2050 deficit is projected to be 350 percent of GDP.

What's driving this, as you've heard at length, is health-care costs and demographic changes. The CBPP has a nice primer if you want to dig into it. But health-care costs and demographic changes are happening way faster than wage increases. There's no tax regime in the world that can keep up indefinitely.

Another way of putting this: I've heard Tyler Cowen say that he asks conservatives when they'll support a VAT. It's easy (at least in theory) to support deep spending cuts in year one and year two and year three and year four, but straight cuts through to year 40? And beyond? Eventually, you need revenue. And I'd say the same goes for liberals: You can raise taxes on the rich in year one and year two and year three, but in year 40?

Eventually, we're just going to have to get the growth of health-care costs down. There's simply no other way.

And, of course, every single effort to reduce health care costs, whether through government or private mechanisms, will prompt shrill demagogic cries of "RATIONING!!" and scorched-earth obstructionist tactics from whichever side is in opposition.

I'd say that to solve this we need to go one level higher and make some pretty radical political reforms.

Conservatives seem to argue that vouchers are the best way to bring about efficiency-increasing changes in the health care system. But if Medicare and Medicaid are already underpaying providers, why hasn't this led to the same types of changes? If fee for service is the problem, or the ability to pass costs on to private insurers, it's tough to see how vouchers are a better answer than other payment reforms.

Ezra, the deficit in 2009 was not 53% of GDP, and its not projected to be 350% of GDP at any point in the future. As you probably should have picked up by now, it is very difficult of a country to run a deficit of greater than 100% of GDP, since the public sector deficit is a component of GDP (technically, you could be running a very big trade deficit, and end up with a pub sec def/GDP ratio above 1). I think you must be referring to the debt, but then its not clear if the $9 trillion over 2010-2019 is the cumulative increase in debt (the deficits added up) or the deficit at the end of that time period (which would be pretty close to 50% of GDP, if it got that big).

Not all conservatives argue that vouchers are the best way to bring about efficiency-increasing changes in the health care system. Payment reforms may or may not work, but healthcare rationing is a legitimate way to control healthcare costs. Conservatives have no trouble citing the potential abuse of "free" healthcare, or stories that suggest 100 people are responsible for 90% of emergency room visits (and thus near 90% of the cost incurred) here and there.

How do you solve that problem? You track who is abusing the system, and you ration care (or you direct people with a compulsive need to fake illness to receive the appropriate mental health care). In this case, the market is not the most efficient rationer of care if the goal is longevity and overall societal health. Because people will make economic, convenience, and fear-based decisions regarding preventive medicine and physical exams. Insurers will often ration care strictly on cost. Physicians will often not ration care based on health, for numerous reasons. Thus, as inefficient as the government is (such inefficiencies being inherent in large bureaucracies), a government panel to establish best practices and how care should be "rationed" (which it always is, and always has to be, anyway, as the availability of anything is not infinite) may be the best approach.

I don't think you're going to avoid the complaint of rationed healthcare, because any serious solution is going to involve the intelligent rationing of healthcare.

Has anyone looked at a financial transactions tax that targets day and computer trading (an exclusion for positions held 30-60 days would exempt most long term investors)? That is where these financial institutions and hedge funds are skimming off trillions of dollars by doing essentially nothing for the productive economy.

I am also in favor of a modest wealth tax that would balance out the wealth tax that is paid by the middle class on the largest or only asset they have (if they are lucky enough) which is their house. This gets taxed annually, but other asset classes do not get taxed, only the proceeds from the assets are taxed and at a lower rate than regular income. This is a fundamental imbalance that must be addressed.

How much of this is SS? Significantly raising or eliminating the payroll tax cap would go a long way toward making that system sound.

I agree we have to reduce health care costs and support those measures. But it looks like you are just considering modest (1-2%) changes in marginal income tax rates. We could also:

(1) Drop the preferential tax rate for dividends and tax everything after the first $3000 or so as ordinary income. This is how it was in the 1960s (then a $600 exclusion). And put the cap0 gains rate back to 20%.

(2) Raise top marginal rates even more, say 5%.

(3) Raise the estate tax. What assumption is built in here? Freeze the exclusion at $3.5 million or keep the current regime of no estate tax?

(4) Increase the corporate tax, or close loopholes to make the corps pay their fair share, considering how much of the gov't exists to safeguard their property and profits and settle their disputes.

(5) Add a modest .025% tax on financial transactions.

These would raise more revenue. People who make more than a million doillars a year can well afford to give back some of the gains the tax system afforded them over the past 10 years.

its nice to see an admission that we can't just "tax somebody else" to get the revenues we'll need and we'd need some entitlement reform as well.

Any realistic conservative realizes that we'll need to ration healthcare in the future. Efficiency only gets you so far. Once though you get past paying for the baby boomer generation I think you'll see things come more in balance.

Not all conservatives argue that vouchers are the best way to bring about efficiency-increasing changes in the health care system. Payment reforms may or may not work, but healthcare rationing is a legitimate way to control healthcare costs.

Posted by: Kevin_Willis | April 9, 2010 11:02 AM | Report abuse

Kevin,

Don't you know a liberal talking point when you see one ;-) Don't you know that conservatives live to "screw poor people" out of the little money they have?

1) We don't need to eliminate the deficit. We just need to make it small enough, and have enough growth, so that the debt-to-GDP ratio stays healthy.

2) Under Clinton, we managed just fine - in fact had unprecedented global military dominance - on about $300B/year. Now we spend about $700B/year. Plus another $50-80B on the mish-mash of non-military intelligence agencies. I reckon we could be just as safe with a $250B/year defense budget - still about 4x larger than Russia or China. And that saves about $4.5T over 10 years.

Problem solved. If you can figure out how to do it politically ... though I actually I think the first step is to educate the public about just how vast our military spending is, and how weak and poor all plausible adversaries are.

The top tax rate in 1964 was reduced to something like 70%. That brought it down from the 90+% it was in the 1950s, a time considered to be an economic boom era. Sure, maybe somebody at $200K shouldn't be paying 70%, but somebody making $5 million should probably be paying a lot more.

@VB: I am sure you are aware of the stratospheric rise in the incomes of the oligarchs over the last 10 years, while middle class incomes stayed stagnant.

Yet you want to have the middle class pay more in taxes? Do you agree that the payroll tax cap should raised and structured so it captures all income (cap gains tax would be reduced so that the payroll + cap gains tax on dividends and interest would = 20-25%)?

What do you have against a modest financial transactions tax that targets short term and computer trading? Isn't this were trillions of dollars are made with out actually contributing to the productive economy?

Why should real estate wealth be taxed and other asset classes not taxed?

After these are implemented, if the deficit and debt problem are still severe, I would consider tapping the middle class for more money.

Raising the tax rates isn't even all that necessary. Eliminating tax expenditures is strongly progressive and would result in a simpler tax code. It won't have the benefit of controlling inflation in the health care sector, but it's a good start and balancing the budget.

There's no good policy reason why realized capital gains should be treated differently from other income, or why mortgage interest or employer provided insurance should be deductible.

The value of the major expenditures (estimated at around $500 billion for next year) is summed up in a graph here:
http://crfb.org/blogs/top-ten-tax-expenditures-jct-releases-its-annual-report

I don't think I've suggested that the rich can't pay more but as Ezra seems to agree there's a point where that's just not going to happen. Sure tax them until it gets us nothing more but don't forget about entitlement reform while you're at it.

I'm fine with the transaction tax. I just was offended by the "list" given to continue to tax "OPM". That's easy to do. I'd like to see EVERYONE share the burden that's all.

Maybe we should define the "rich" as anyone making 6 figures? Makes sense to me, and to most Americans I suspect. (Of course, most everyone who reads the Post has a household income in that range, so it will never happen.)

Looks like we got half the solution there. The other half needs to consist of serious cuts in the imperial military bloat and serous rationalizing of a universal health system. Not impossible, but probably not until things get worse -- in all the those areas: inequality, imperial decline, and health provision insanity.

Typo alert in "the 2009 deficit was 53 percent of GDP. The 2050 deficit is projected to be 350 percent of GDP."
"deficit" should be "debt."

Note the funny coincidence that eliminating the 10 year deficit (assuming no affect of taxes on taxable income) would involve raising rates from 50%-18.9 to 50% + 18.9 so raising the rate to 50% would cut the 10 year deficit in half (except for the effect on taxable income so the deficit would really be more than half of the projected deficit).

On the other hand, that is assuming that capital gains taxes and inheritance taxes remain the same. Increasing the tax on capital gains for people with income over $200,000 and families with income over $250,000 would reduce the deficit more.

Even taxing estates of less than 7,000,000 if the heirs had income over $200,000/$250,000 would add a lot (high income parents have high income children and heirs tend to be near the age of maximum earnings).

Plus I mean people who inherit a million might be considered rich even if they didn't have very high income.

@ visionbrkr : I think that the burden should be shared in proportion to what groups have actually prospered (ie top 5 %) during the last 30 years and what groups (the rest of us) who have had basically stagnant wages. Household income only went up because 2 earner families replaced 1 earner families over that time span.

Sure there is a top limit on income taxation when the law of diminishing returns sets in but we are very far away from that.

Aside from the revenue side, isn't it OK to use tax policy to discourage the continued formation of an oligarch class like the robber barrons of the early 20th century?

@ bharshaw : WE need to distinguish the "rich" from the oligarchs like warren buffett and bill gates. I think that we can be generous and call people with 200K incomes or families with 250k incomes rich. once income gets over 2 million, I think we can use the term oligarch.

Ok a little history on tax rates. When the top marginal rate was 90% there were numerous loopholes. For instance your company could provide you at no tax the following benefits among others. Free club memberships, a car, airline travel for you and your spouse, free clothing etc. Now of course all of those benefits are taxable. The effective tax was as they say effectively lower.

The most important thing however is that was a period when the USA was the dominant industrial country in the world by a large margin and other countries were trying to recover from the devastation of WWII.Eventually those tax rates led to stagnation and a democratic president lowered the rates.

A few other tidbits.Over half of the top 1% of the taxpayers in any one year are individuals who worked ther whole lives for peanuts and then sold a business or cashed out their investments and report a large income. The next year they are back in the mainstream. You would tax these people at 90%. Why would anyone work hard under these circumstances.

The higher the tax rate the more the corruption. You can see it in every day activities. For instance in NYC the amount of smoking that goes on is 3 times larger than the actual tax receipts would suggest and it is getting worse. You can make $100,000 smuggling a truckload of cigaretes into the city and selling them under the counter.

Ok a little history on tax rates. When the top marginal rate was 90% there were numerous loopholes. For instance your company could provide you at no tax the following benefits among others. Free club memberships, a car, airline travel for you and your spouse, free clothing etc. Now of course all of those benefits are taxable. The effective tax was as they say effectively lower.

The most important thing however is that was a period when the USA was the dominant industrial country in the world by a large margin and other countries were trying to recover from the devastation of WWII.Eventually those tax rates led to stagnation and a democratic president lowered the rates.

A few other tidbits.Over half of the top 1% of the taxpayers in any one year are individuals who worked ther whole lives for peanuts and then sold a business or cashed out their investments and report a large income. The next year they are back in the mainstream. You would tax these people at 90%. Why would anyone work hard under these circumstances.

The higher the tax rate the more the corruption. You can see it in every day activities. For instance in NYC the amount of smoking that goes on is 3 times larger than the actual tax receipts would suggest and it is getting worse. You can make $100,000 smuggling a truckload of cigaretes into the city and selling them under the counter.

In a recent AP piece reporting on who pays the lion's share of federal income taxes in America, Stephen Ohlemacher correctly stated that the top 10 percent of earners (based on federal adjusted gross income, or AGI) pay 73 percent of federal personal income taxes. This is a standard line of argumentation for those hoping to advance the notion that prosperous Americans bear a grossly disproportionate share of the tax burden in an unfairly progressive system of taxation, but such a selective citation belies the fact that this same top 10 percent of earners account for approximately 50 percent of the aggregate AGI reported on federal income tax returns -- even with flat, one-rate-for-all federal taxation on personal income, the top 10 percent of earners would pay a disproportionate share of personal income tax for the simple fact that they earn a quite sizably disproportionate share of the total reported earnings. Moreover, federal personal income tax is only part of the larger individual tax burden that Americans bear, and when payroll, state and local taxes are included, the real truth emerges -- those top earners are scarcely carrying their own water, let alone anyone else's.

If the bottom 47 percent of earners seem to be paying an inordinately small portion of the federal personal income tax burden, consider that their aggregated earnings represent only about 10 percent of AGI reported to the IRS, a participation in economic prosperity that has fallen by almost 50 percent since 1980. The earnings for many in this number are at or near the levels that define extreme hardship or abject poverty.

But on to the merits of soaking the rich. The record of the last 100 years is very clear -- higher top marginal rates for federal personal income tax correlate to lower unemployment, higher rates of job creation, greater economic stability, and more broadly distributed prosperity. Low top marginal rates for personal income tax (as presently the case) have exactly the opposite historical correlation -- viz., higher unemployment, lower rates of job creation, lesser economic stability, and more narrowly distributed prosperity.

The manner in which well-to-do and wealthy Americans deploy their assets is, in the aggregate, profoundly affected by top marginal rates on personal income tax. Low top marginal rates for personal income tax result in an aggregate bias toward relatively short time-horizon capital accumulation activities (viz., personal wealth building) at the expense of relatively longer time-horizon capital formation activities (viz., business building).

Any plan for restoring this nation to fiscal sobriety and economic prosperity must include a return to top marginal rates in the range of 60-70 percent for the highest earners. Conservatives may find this inconvenient truth to be irksome, but 100 years of history tells a very consistent story -- soaking the rich works. Even for the rich.